Old 'swaps' could be costly for Ocala, other FMPA members

Published: Friday, March 29, 2013 at 4:00 p.m.

Last Modified: Friday, March 29, 2013 at 4:00 p.m.

Time is on its side, but the Florida Municipal Power Agency is wrestling with a problem that, if not solved by Oct. 1, 2015, could push up electric rates charged by its members, which include Ocala's electric utility.

"We have a pretty sophisticated financial team that is evaluating all options," Ocala City Manager Matthew Brower said of FMPA.

That team is looking for ways to get out from under interest rate swap contracts it signed to help keep down the cost of constructing a coal plant in Taylor County.

What seemed like a hot opportunity in 2006, when the market was on fire, suddenly turned to ice when battered by the cold winds of politics and the collapsing economy.

Taylor County plant

FMPA is a wholesale power agency comprised of 31 city-owned electric utilities around the state. By joining together, members strive to keep electric rates low by buying power in bulk and building their own power-generating plants.

Members, depending on their individual needs, decide whether to participate in FMPA projects.

By law, FMPA is required to do a 10-year cycling report due every April 1 in which it tries to forecast the energy needs over 10 years to determine if it has enough power to serve its needs. It takes five to eight years to plan, design, engineer and build a new plant.

"If the day we need generation happens before the day we have new capacity, we are in trouble," Brower said.

In 2006 the economy was booming and construction was exploding. FMPA realized that it would not have enough power to keep pace with the enormous growth that was occurring. To generate more power, it decided to build a coal plant in Taylor County.

"That was before coal was a four-letter word," Brower said. "Coal, at that time, was the most cost-effective means of producing energy, hands down."

FMPA's Taylor County coal plant project has 14 participants, including Ocala. Those 14 members obtain nearly all their power supply from FMPA.

To understand what happened that placed FMPA in its current bind, officials said, it's important to remember how expensive building or repairing power plants can be. For example, FMPA's most recent generation plant, Cane Island Unit 4, a 300-megawatt natural gas plant, went on-line in July 2011 and cost $500 million.

And Duke Energy, before it decided not to proceed, estimated it would cost between $1.3 billion and $3.5 billion to fix the problems at the Crystal River nuclear plant.

Because of those enormous costs, FMPA had to borrow the money to build the Taylor County plant.

"The cost of money becomes critical in financing that debt," Brower said. "We wanted to find the lowest rate possible so our interest costs are held to the minimum they possibly can."

Rate shopping

So, FMPA went shopping for good interest rates, just like a home buyer looking for a mortgage. And interest rates were good in 2006.

But rather than having an interest rate that fluctuates, which would play havoc with utility rates charged to customers, FMPA opted to look for a way to stabilize the interest rate so it could keep utility customers' rates stable. The way it chose to do that was to enter into swap contracts.

The counter party accepts the risk of the fluctuating rate, believing it can make money on the lower variable rate. The debt does not change hands — only the interest rates.

"Now we can keep our rates flat. We also get incredibly good financial rates," Brower said.

Those swap contracts come due on Oct. 1, 2015, when they will be swapped for bonds.

At the time they were secured, the swap contracts were a good deal. But something else happened, besides the souring economy, that has FMPA looking for a way out of.

Coal falls out of favor

On July 12, 2007, the game changed. That is the day Gov. Charlie Crist signed an executive order limiting the amount of carbon dioxide that can be generated in the state of Florida, which essentially eliminated coal as an energy option and killed FMPA's Taylor County coal plant project.

"Now I have a mortgage, but I don't have a house," Brower said.

FMPA only entered the swaps because it had a project, the Taylor County coal plant. By law, FMPA cannot be involved in speculative actions.

"But now we have swaps but we don't have a project. That's a problem." Brower said. "We no longer have a project and Oct. 15, 2015 is coming fast."

And without a project, there can be no bonds.

Without a project FMPA will have to terminate the swap contracts, and the value of what it owns today is less than what it paid.

"We are out of the money and we have to pay a termination cost on the contracts," Brower said.

As of March 21, that termination cost was estimated at $98 million, a figure that changes daily.

One good thing did happen: The market recovered enough in February 2010 that FMPA was able to sell five of the contracts at no net loss. The market has bottomed out since then and FMPA is still holding nine contracts.

Project wanted

To get out of its bind, FMPA is trying to find a project. It just built the Cane Island 4 plant and demand for power is down, so there is no need for more electricity.

The "project" does not have to be a generation plant, Brower said. FMPA could buy natural gas in advance. It spends about $700 million a year buying natural gas. It could buy a large quantity of gas at the current low rate and bank it.

But there is a risk to that strategy: FMPA recently got burned holding highly priced natural gas hedging contracts when natural gas rates plunged. Those hedging contracts were locked in at $10 an MMBtu. Today, natural gas is selling around $3.90 an MMBtu.

"The (FMPA) board hasn't forgotten that," Brower said.

Another option would be to remain in a holding pattern until Oct. 1, 2015 and hope the market goes up. If it does, FMPA could get out of the contracts at no cost. But if it waits and still has no project and the market does not rebound, it will have to terminate the contract and pay the termination fees.

Another option would be to try to renegotiate the contracts with the nine counter parties, which would have a cost. FMPA is trying to figure out what those costs might be. It has not begun any negotiations. And, right now, the holders of those contracts know all the good cards are in their hands.

But the contracts are not up for 2½ years.

"We still have time on our side," Brower said. "We have an incredible team of talented individuals. There are a lot of moving parts we are trying to get our hands around and possibly come up with a solution."

But what if the economy does not recover, unemployment remains high and no project is found by Oct. 15, 2015?

"We would finance and issue debt," Brower said.

And that debt likely would be shared by the 14 members' electric utility rate payers.

<p>Time is on its side, but the Florida Municipal Power Agency is wrestling with a problem that, if not solved by Oct. 1, 2015, could push up electric rates charged by its members, which include Ocala's electric utility.</p><p>"We have a pretty sophisticated financial team that is evaluating all options," Ocala City Manager Matthew Brower said of FMPA.</p><p>That team is looking for ways to get out from under interest rate swap contracts it signed to help keep down the cost of constructing a coal plant in Taylor County.</p><p>What seemed like a hot opportunity in 2006, when the market was on fire, suddenly turned to ice when battered by the cold winds of politics and the collapsing economy.</p><h3>Taylor County plant</h3>
<p>FMPA is a wholesale power agency comprised of 31 city-owned electric utilities around the state. By joining together, members strive to keep electric rates low by buying power in bulk and building their own power-generating plants.</p><p>Members, depending on their individual needs, decide whether to participate in FMPA projects.</p><p>By law, FMPA is required to do a 10-year cycling report due every April 1 in which it tries to forecast the energy needs over 10 years to determine if it has enough power to serve its needs. It takes five to eight years to plan, design, engineer and build a new plant.</p><p>"If the day we need generation happens before the day we have new capacity, we are in trouble," Brower said.</p><p>In 2006 the economy was booming and construction was exploding. FMPA realized that it would not have enough power to keep pace with the enormous growth that was occurring. To generate more power, it decided to build a coal plant in Taylor County.</p><p>"That was before coal was a four-letter word," Brower said. "Coal, at that time, was the most cost-effective means of producing energy, hands down."</p><p>FMPA's Taylor County coal plant project has 14 participants, including Ocala. Those 14 members obtain nearly all their power supply from FMPA.</p><p>To understand what happened that placed FMPA in its current bind, officials said, it's important to remember how expensive building or repairing power plants can be. For example, FMPA's most recent generation plant, Cane Island Unit 4, a 300-megawatt natural gas plant, went on-line in July 2011 and cost $500 million.</p><p>And Duke Energy, before it decided not to proceed, estimated it would cost between $1.3 billion and $3.5 billion to fix the problems at the Crystal River nuclear plant.</p><p>Because of those enormous costs, FMPA had to borrow the money to build the Taylor County plant.</p><p>"The cost of money becomes critical in financing that debt," Brower said. "We wanted to find the lowest rate possible so our interest costs are held to the minimum they possibly can."</p><h3>Rate shopping</h3>
<p>So, FMPA went shopping for good interest rates, just like a home buyer looking for a mortgage. And interest rates were good in 2006.</p><p>But rather than having an interest rate that fluctuates, which would play havoc with utility rates charged to customers, FMPA opted to look for a way to stabilize the interest rate so it could keep utility customers' rates stable. The way it chose to do that was to enter into swap contracts.</p><p>FMPA bought $500 million worth of swap contracts at a favorable 3.92 percent interest rate. Basically, FMPA "swapped" its variable interest, which was a little lower rate, for the counter parties' slightly higher fixed rate.</p><p>The counter party accepts the risk of the fluctuating rate, believing it can make money on the lower variable rate. The debt does not change hands — only the interest rates.</p><p>"Now we can keep our rates flat. We also get incredibly good financial rates," Brower said.</p><p>Those swap contracts come due on Oct. 1, 2015, when they will be swapped for bonds.</p><p>At the time they were secured, the swap contracts were a good deal. But something else happened, besides the souring economy, that has FMPA looking for a way out of.</p><h3>Coal falls out of favor</h3>
<p>On July 12, 2007, the game changed. That is the day Gov. Charlie Crist signed an executive order limiting the amount of carbon dioxide that can be generated in the state of Florida, which essentially eliminated coal as an energy option and killed FMPA's Taylor County coal plant project.</p><p>"Now I have a mortgage, but I don't have a house," Brower said.</p><p>FMPA only entered the swaps because it had a project, the Taylor County coal plant. By law, FMPA cannot be involved in speculative actions.</p><p>"But now we have swaps but we don't have a project. That's a problem." Brower said. "We no longer have a project and Oct. 15, 2015 is coming fast."</p><p>And without a project, there can be no bonds.</p><p>Without a project FMPA will have to terminate the swap contracts, and the value of what it owns today is less than what it paid.</p><p>"We are out of the money and we have to pay a termination cost on the contracts," Brower said.</p><p>As of March 21, that termination cost was estimated at $98 million, a figure that changes daily.</p><p>One good thing did happen: The market recovered enough in February 2010 that FMPA was able to sell five of the contracts at no net loss. The market has bottomed out since then and FMPA is still holding nine contracts.</p><h3>Project wanted</h3>
<p>To get out of its bind, FMPA is trying to find a project. It just built the Cane Island 4 plant and demand for power is down, so there is no need for more electricity.</p><p>The "project" does not have to be a generation plant, Brower said. FMPA could buy natural gas in advance. It spends about $700 million a year buying natural gas. It could buy a large quantity of gas at the current low rate and bank it.</p><p>But there is a risk to that strategy: FMPA recently got burned holding highly priced natural gas hedging contracts when natural gas rates plunged. Those hedging contracts were locked in at $10 an MMBtu. Today, natural gas is selling around $3.90 an MMBtu.</p><p>"The (FMPA) board hasn't forgotten that," Brower said.</p><p>Another option would be to remain in a holding pattern until Oct. 1, 2015 and hope the market goes up. If it does, FMPA could get out of the contracts at no cost. But if it waits and still has no project and the market does not rebound, it will have to terminate the contract and pay the termination fees.</p><p>Another option would be to try to renegotiate the contracts with the nine counter parties, which would have a cost. FMPA is trying to figure out what those costs might be. It has not begun any negotiations. And, right now, the holders of those contracts know all the good cards are in their hands.</p><p>But the contracts are not up for 2½ years.</p><p>"We still have time on our side," Brower said. "We have an incredible team of talented individuals. There are a lot of moving parts we are trying to get our hands around and possibly come up with a solution."</p><p>But what if the economy does not recover, unemployment remains high and no project is found by Oct. 15, 2015?</p><p>"We would finance and issue debt," Brower said.</p><p>And that debt likely would be shared by the 14 members' electric utility rate payers.</p><p><I>Contact Susan Latham Carr at 867-4156 or susan.carr@starbanner.com.</i></p><p></p>